Friday, February 12, 2010

Update: check out the new graphic by Tild inspired by Tim Pawlenty’s call to reduce the corporate income tax by twenty percent in the face of a projected 1.2 billion dollar deficit in the currrent biennium. (See a discussion of that further down in the post.) Sweet.

I’ve had a couple of posts this week about the corporate income tax, taking off initially on Todd Rapp’s op-ed advocating the elimination of the corporate income tax in Minnesota. The main point of the posts was, really, to offer the point of view that corporations consume state services just as individuals do, and that it is illogical and unfair to eliminate this tax, especially to just trade the revenue it produces for some ephemeral prospect of growth.

Eliminate the corporate income tax types like to argue that corporations just “shift” the taxes they pay to consumers. The real shift, however, would take place if individuals had to bear the cost of all the things that corporations benefit from: the court system (we must enforce those contracts!), roads, law enforcement, civil defense, the education of a workforce, and of course, the list goes on.

If a corporation has to pay for government services, that gets included in the price for its goods or services; I submit that that results in a more accurate price of the cost of those goods or services. That isn’t shifting so much as cost accounting.

In the last decade, the size of state government has decreased as a percentage of state income, and we have crumbling roads, underfunded schools, neglected cities, fallings bridges, and all of the other indicia of malign neglect to prove it. But in his State of the State address, Governor Pawlenty tells us he wants to cut taxes some more, including a 20% reduction in the corporate income tax.

The previous posts have been about the philosophy behind the fairness of a corporate income tax. But now, especially in view of the governor’s remarks, it is time to talk turkey about the state income tax and how it works.

The rap, so to speak, and as mentioned, on state income taxes, that they are just shifted to individual residents and taxpayers, rests on the premise that Minnesota is like a terrarium; that is, it is a closed system. But it never was, really, and our state economy is becoming increasingly open.

So a real question is whether we want not only corporations domiciled here, but corporations that have facilities here, and probably sales and employees, too (but the highly-paid executives and the shareholders are elsewhere), to help pay the cost of running the government that they also benefit from. Corporations that have a trade or business that is considered effectively connected to Minnesota have to pay income taxes on that part of the business, whether they are Minnesota companies or not.

The allocation of income for a corporation to a state where it isn’t domiciled is usually calculated using a three factor formula; that’s the way Minnesota does it, too. The three factors are sales, personnel, and factories or other facilities.

It should be dawning on you by now that a corporation domiciled in Minnesota, but with plants, and employees and sales around the country is likely to have to pay income tax in many states, and that is, in fact the case. Most of the time, and for most of the taxes, the income taxes paid to other states are taken as a credit against the taxes owed by a Minnesota-based company to the Minnesota Department of Revenue.

A Minnesota-based company is going to owe the income taxes to the other states, even if the Minnesota rate is slashed by 20%. There is no guarantee, therefore, that the Minnesota-based company will see a 20% decrease in overall state income taxation, not at all.

What is certain, however, is that we will collect 20% less income tax from non-Minnesota companies that have a substantial presence here and have part of their business that is subject to the Minnesota income tax. They will still be able to sue in Minnesota courts, get deliveries of raw materials, ship finished goods, hire educated Minnesota workers; they’ll just have to pay 20% less.

This is the real cost shifting.

People favoring the reduction or elimination of the state income tax might say this good; it will attract investment to Minnesota.

This is part of what Spot calls the Hey, Sailor, c’mere; you want a free one? approach to attracting investment. It may bring some, um, fast returns, but long term it will contribute to turning Minnesota into Mississippi. In fact, Haley Barbour, the governor of Mississippi is coming here; maybe he’s looking the place over, thinking to set up a colony. Or a casino, anyway. Maybe he and Dick Day will get together while Haley’s here.

One other thing that the guv mentioned in his address was that the Minnesota corporate income tax rate was, like, the highest on planet earth. Something like that anyway. But there is an important part of the taxation puzzle in many parts of the world that is unfamiliar to Minnesotans and indeed, Americans. In Canada, it’s called the goods and services tax, and in other countries it is often called the value added tax, or VAT.

The existence of the VAT makes the direct comparison of income tax rates of limited utility.